I am the Cordell Professor of Finance at the University of Florida’s Warrington College of Business Administration. I have been writing on initial public offerings (IPOs) for over 30 years and I speak publicly at IPO forums and seminars world-wide. I have been quoted hundreds of times in the Financial Times, New York Times, USA Today, Wall Street Journal, and Washington Post, and I appear occasionally on Bloomberg TV/Radio, CNBC, and Fox Business. Google Scholar records over 26,000 citations to my work. I do some consulting and have been a mutual fund trustee, and I am president of the Financial Management Association for 2014-15. In my personal investing, over time I have beaten the market, mainly through successful market timing rather than picking individual securities that have outperformed.

Google's IPO, 10 Years Later

On August 19, 2004, GoogleGoogle went public in a highly anticipated initial public offering that valued the six-year old company at what seemed to be an astronomical $23 billion, with a price-earnings ratio of 80, a mere six years after its founding. The company was already generating annualized revenue of $2.7 billion and profits of $286 million. Today, Google’s market cap is $390 billion, with annualized revenue of $64 billion and profits of $13 billion. Google’s market cap is the third highest of any U.S. company, with only AppleApple and Exxon MobilExxon Mobil being bigger. Public market buy-and-hold investors have scored a “ten-bagger”, earning a return of more than 1,000% over the decade. I didn’t buy at the IPO, but I have bought GOOG since then, and continue to hold shares today.

Google’s IPO was unconventional, starting with a registration statement stating that the company was planning to raise $2,718,281,828, a number that confused the many journalists who hadn’t memorized the number “e” to the ninth decimal place, as any serious quant would have. Famously, the Letter from the Founders contained in the prospectus stated a corporate goal of “Don’t be evil.” Several years later, the company decided to honor this commitment by pulling out of China rather than agreeing to facilitate government censorship of search results.

Google bargained with its investment bankers to lower the fees that are charged, and paid 2.8% rather than the more normal 4% that a multi-billion dollar deal would normally face. Most IPOs, and almost all of those that raise $50-200 million, pay their bankers 7% of the proceeds.

Unlike most IPOs, the company used an auction to sell shares. Close to two years before the IPO, I had met with Google’s founders to discuss the merits of using an auction versus the more traditional way of selling shares, known as bookbuilding. I was not involved in the details of the actual offering, however.

An auction, at least in theory, should deliver the highest possible price for the company while giving individual investors, rather than just the fund managers who dominate the bookbuilding approach, the opportunity to buy shares. But by the time Google launched the IPO, it had scaled back the size of the stock sale and lowered the offering price in the face of weak demand. After setting a price range of $108-135 per share, Google went public at only $85 per share, selling just 22.5 million shares and raising just $1.9 billion. Adding insult to injury, the stock rose 18 percent on the first day of trading to close at $100.34 — suggesting that the auction failed to achieve its purpose of setting a price as close as possible to the value investors would award the stock on the open market. The IPO was largely viewed as a fiasco.

Part of the reason that the offering raised less money than expected was simply bad luck: In the weeks leading up to the IPO, both the technology-laden Nasdaq market and shares of YahooYahoo, Google’s top rival at the time, had been drifting downwards, sending a chill through the IPO market.

Two other factors, however, were even more important. The first factor was that the “road show” did not go well. When a company goes public, in an attempt to stimulate demand, the top managers and the investment bankers hired to take the company public typically spend up to two weeks going from city to city making presentations to institutional investors and answering questions. Google’s management, however, refused to answer many of the questions that were asked. As a result, investors were less willing than normal to give the company the benefit of the doubt about its future profitability.

The second factor that lowered the offer price was the desire of the lead underwriters, Credit Suisse and Morgan StanleyMorgan Stanley, to sabotage the auction. Underwriters find the bookbuilding system to be very profitable, and most feel threatened by auctions. With an auction, the underwriters no longer have the power to allocate underpriced shares to their favorite customers. Consequently, the lead underwriters didn’t want the auction to be viewed as a success. They didn’t want it to be a complete failure, however, since they were the lead underwriters. The underwriters told many institutional investors that they were likely to receive shares if they bid $85 per share. Not surprisingly, there were a huge number of bids for shares at $85, and relatively little demand at a higher offer price. Google was forced to accept just $85 per share.

Google and the selling shareholders thus raised less money than they could have in the IPO. But the offer was selling only 8% of the company, and the employees and others who held their shares were amply rewarded as the stock rose, and rose further, as profits increased from $286 million per year to $13 billion per year. Google has proven that targeted search advertising can be an enormously profitable business, which is why Facebook was able to get a valuation of $104 billion when it went public in 2012.

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